Indian government officials are pressing financial regulators to further tighten rules regarding the use of derivative-backed structures called participatory notes, fearing they are being sold to Indian investors and may be misused. Traders fear the rumblings will undermine the notes, which at end-June accounted for nearly a quarter of all foreign institutional investor investments in Indian equity. "When the regulator changes things the market tends to get jittery," said one senior trader.
The concern of the finance ministry is the notes are open to misuse, reportedly including money laundering activities, by Indian nationals. It believes that Indian nationals buy the notes to disguise their investment activities and identities from the Securities and Exchange Board of India. Traders now fear SEBI will seek greater levels of disclosure over the end-users from investment banks. Officials at the regulator did not respond to e-mailed questions by press time.
Participation notes offer foreign investors access to Indian stocks via derivatives. They give exposure to investors that are prohibited from investing directly because they cannot or have not registered with SEBI. The contracts are hedged via onshore positions held by firms.
One senior bulge-bracket equity trader disputed that the notes could get into Indian hands because the regulations are already strict. Firms have to file a monthly report with the SEBI showing the identities of all buyers and sign a declaration that they have not been sold to Indians, non-resident Indians, persons of Indian origin, or offshore corporations more than 60% owned by these groups.
This isn't the first time the issue has been a hot button: UBS was barred from the market over the disclosure of investor identities for a while until an appeals court ruling threw out the case (DW, 5/20/05).
According to a report in the Times of India the finance ministry has come under criticism recently over the misuse of the notes, spurring it to pressure SEBI.
